Wall Street was quick in giving its opinion of LSI Logic's (NYSE:LSI) $4 billion purchase of Agere Systems (NYSE:AGR). On the news, LSI's stock plunged more than 13%. While this deal provides some growth potential -- and cost savings -- it looks like Wall Street has the right assessment of the upcoming challenges.
LSI develops a comprehensive line of semiconductors that allow for storage. Its technologies are found in such consumer devices as digital home DVD recorders, set-top boxes, and portable media players (more than 350 million consumer devices have LSI chips). In fact, the company won two Emmy Awards because of its innovative graphics chips.
As for Agere Systems, it develops storage chips, as well. However, its focus is on categories like mobile and telecommunications networks (such as helping to deliver broadband services). What's more, the company is a patent machine -- with more than 5,800 issued, it is still generating 20 new patents per month.
Financially, Agere has staged a turnaround over the past year, and turned profitable in fiscal 2006. There should also be growth from marquee customers like Seagate (NYSE:STX) and Samsung.
The combined entity will have roughly $3.5 billion in sales. Moreover, the estimate is for at least $125 million in cost savings by 2008, which should "meaningfully" boost earnings. On the other hand, the deal is expected to be "slightly" dilutive to LSI's earnings in 2007.
Slightly? Meaningfully? Well, Wall Street usually receives such things with skepticism.
After all, LSI is paying a premium for Agere, whose enterprise value (market capitalization + debt - cash) is at about 2.5 times revenues (the industry average is about 2). Other deals in the sector have been much cheaper, such as AMD's (NYSE:AMD) acquisition of ATI Technologies (2 times). In other words, LSI has a high hurdle to prove its transaction.
Admittedly, there is much potential with the deal. But there will certainly be major challenges in terms of integrating a massive organization -- as well as making the transition into two new categories, mobile and networking. And the history of such big deals, especially in the tech sector, has not been encouraging.
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Fool contributor Tom Taulli does not own shares mentioned in this article. He is currently ranked 380 out of 14,555 in Motley Fool CAPS.
